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IKNX > SEC Filings for IKNX > Form 10-Q on 14-May-2014All Recent SEC Filings

Show all filings for IKONICS CORP

Form 10-Q for IKONICS CORP


14-May-2014

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following management's discussion and analysis focuses on those factors that had a material effect on the Company's financial results of operations during the first quarter of 2014 and for the same period of 2013. It should be read in connection with the Company's condensed unaudited financial statements and notes thereto included in this Form 10-Q.

Critical Accounting Estimates

The Company prepares its financial statements in conformity with accounting principles generally accepted in the United States of America. Therefore, the Company is required to make certain estimates, judgments and assumptions that the Company believes are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The accounting estimates, which IKONICS believes are the most critical to aid in fully understanding and evaluating its reported financial results, include the following:

Trade Receivables. The Company performs ongoing credit evaluations of its customers and adjusts credit limits based upon payment history and the customer's current credit worthiness, as determined by review of the current credit information. The Company continuously monitors collections and payments from its customers and maintains a provision for estimated credit losses based upon historical experience and any specific customer collection issues that have been identified. While such credit losses have historically been within expectations and the provisions established, the Company cannot guarantee that it will continue to experience the same collection history that has occurred in the past. The general payment terms are net 30-45 days for domestic customers and net 30-90 days for foreign customers. A small percentage of the trade receivables balance is denominated in a foreign currency with no concentration in any given country. At the end of each reporting period, the Company analyzes the receivable balance for customers paying in a foreign currency. These balances are adjusted to each quarter or year spot rate in accordance with guidance related to foreign currency matters.

Inventories. Inventories are valued at the lower of cost or market value using the last in, first out (LIFO) method. The Company monitors its inventory for obsolescence and records reductions in cost when required.

Income Taxes. At March 31, 2014, the Company had net current deferred tax assets of $150,000 and net noncurrent deferred tax liabilities of $527,000. The deferred tax assets and liabilities result primarily from temporary differences in property and equipment, accrued expenses, and inventory reserves. At March 31, 2014, the Company recorded a valuation allowance of $326,000, of which $17,000 is related to a Minnesota research and development credit which expires in 15 years and $309,000 pertains to a U.S. federal capital loss carryovers. The Company believes it is more likely than not that these deferred tax assets will not be utilized in future years. The capital loss carryover is from recording an impairment charge that occurred in 2009. It can only be used against a capital gain and expires at the end of 2014. The Company has determined that is more likely than not that the remaining deferred tax assets will be realized and that an additional valuation allowance for such assets is not currently required. The Company accounts for its uncertain tax positions under the provision of FASB ASC


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740, Income Taxes. At March 31, 2014 and December 31, 2013, the Company had no reserves for uncertain tax positions.

Revenue Recognition. The Company recognizes revenue on sales of products when title passes which can occur at the time of shipment or when the goods arrive at the customer location depending on the agreement with the customer. The Company sells its products to both distributors and end-users. Sales to distributors and end-users are recorded based upon the criteria governed by the sales, delivery, and payment terms stated on the invoices from the Company to the purchaser. In addition to transfer of title / risk of loss, all revenue is recorded in accordance with the criteria outlined within the provisions regarding revenue recognition including:

(a) persuasive evidence of an arrangement (principally in the form of customer sales orders and the Company's sales invoices)

(b) delivery and performance (evidenced by proof of delivery,
e.g. the shipment of film and substrates with bill of lading used for proof of delivery for FOB shipping point terms, and the carrier booking confirmation report used for FOB destination terms). Once the finished product is shipped and physically delivered under the terms of the invoice and sales order, the Company has no additional performance or service obligations to complete

(c) a fixed and determinable sales price (the Company's pricing is established and is not based on variable terms, as evidenced in either the Company's invoices or the limited number of distribution agreements; the Company rarely grants extended payment terms and has no history of concessions)

(d) a reasonable likelihood of payment (the Company's terms are standard, and the Company does not have a substantial history of customer defaults or non-payment)

Sales are reported on a net basis by deducting credits, estimated normal returns and discounts. The Company's return policy does not vary by geography. The Company is not under a warranty obligation and the customer has no rotation or price protection rights. Freight billed to customers is included in sales. Shipping costs are included in cost of goods sold.

Self-Funded Medical Insurance. The Company has a self-funded medical insurance plan and utilizes an administrative service company or a "third party administrator" to supervise and administer the program and act as the Company's fiduciary and representative. The Company has reduced its risk under this self-funded plan by purchasing both specific and aggregate stop-loss insurance coverage for individual claims and total annual claims in excess of prescribed limits. The Company records estimates for claim liabilities based on information provided by the third-party administrators, historical claims experience, the life cycle of claims, expected costs of claims incurred but not paid, and expected costs to settle unpaid claims. The Company regularly monitors its estimated insurance-related liabilities. Actual claims experience may differ from the Company's estimates. Costs related to the administration of the plan and related claims are expensed as incurred. The total liability for self-funded medical insurance was $55,000 as of March 31, 2014 and is included within other accrued expenses in the balance sheets.

Results of Operations

Quarter Ended March 31, 2014 Compared to Quarter Ended March 31, 2013

Net Sales. The Company's record first quarter 2014 sales of $4.5 million were 11.0% higher than first quarter of 2013. Compared to the first quarter of 2013, IKONICS Imaging sales grew $718,000 to $1,562,000. IKONICS Imaging growth is mainly attributable to a large initial stocking order from its new distributor, JDS Industries. Improved IKONICS Imaging equipment sales and an 11.1% increase in DTX sales also positively impacted first quarter results. These increases were partially offset by a 17.7% decrease in Export sales due to


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weaker sales to Asia. The Company believes that part of the Asian sales shortfall is due to weather related shipping delays and shipment levels will rebound closer to historic levels in the final nine months of 2014. Micro-Machining sales were also down 22.1% due to loss of a large mask customer while Domestic sales for the first quarter of 2014 were similar to same period last year.

Gross Profit. Gross profit was $1.8 million, or 39.4% of sales, in the first quarter of 2014 compared to $1.5 million, or 36.4% of sales, for the same period in 2013. The 2014 first quarter gross margin percentage increase is due to a more favorable sales mix related to the increase in IKONICS Imaging sales and a decrease in Export sales. An increase in DTX and Micro-Machining production costs negatively impacted 2014 first quarter gross margins. The Micro-Machining production cost increase is related to the Company's efforts to improve its production capacity and capabilities, while the DTX cost increase is related to the Company allocating resources, both personnel and equipment, to produce textured prints. Some the DTX resources used in the production of textured prints were previously utilized in a selling and administrative capacity.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $1.3 million, or 29.1% of sales, in the first quarter of 2014 compared to $1.5 million, or 36.4% of sales, for the same period in 2013. The decrease in selling, general and administrative expenses reflects lower direct selling and promotional expenses in the screen printing markets as the Company incurred additional promotional and selling expenses related to the introduction of new products in 2013. DTX selling, general and administrative expenses also decreased in the first quarter of 2014 compared to the same period last year as internal resources previously involved with selling, general and administrative duties were reassigned to the production of textured prints in 2014.

Research and Development Expenses. Research and development expenses during the first quarter of 2014 were $143,000, or 3.2% of sales, versus $173,000, or 4.3% of sales, for the same period in 2013. The decrease is due to decreased costs in the first quarter of 2014 for lab supplies and production trials.

Interest Income. The Company earned $2,000 of interest income in the first quarter of 2014 compared to $2,200 of interest income in the first quarter of 2013. The interest earned in the first quarter of 2014 and 2013 is related to interest received from the Company's short-term investments, which consist of fully insured certificates of deposit with original maturities ranging from six to twelve months.

Income Taxes. For the first quarter of 2014, the Company realized income tax expenses of $112,000, or an effective rate of 35.4%, versus an $84,000 tax benefit in the first quarter of 2013. The Company's 2013 first quarter tax benefit was favorably impacted by 2012 tax law changes related to research and development credits and depreciation. These tax law changes were implemented in the first quarter of 2013 and were not allowed to be included in the Company's 2012 tax provision under Generally Accepted Accounting Principles. Accordingly, the benefits from these 2012 tax law changes were recognized in the first quarter of 2013. The income tax provision for the 2014 and 2013 periods also differs from the expected tax expense due to the benefits of the domestic manufacturing deduction, and other non-deductible items.

Liquidity and Capital Resources

The Company has financed its operations principally with funds generated from operations. These funds have been sufficient to cover the Company's normal operating expenditures, annual capital requirements, and research and development expenditures.

Cash and cash equivalents were $2,143,000 and $1,704,000 at March 31, 2014 and December 31, 2013, respectively. The Company generated $354,000 in cash for operating activities during the three months ended March 31, 2014, compared to using $248,000 of cash from operating activities during the same period in 2013. Cash provided by or used in operating activities is primarily the result of net income (loss) adjusted for non-cash depreciation, amortization, and certain changes in working capital components discussed in the following paragraph.

During the first three months of 2014, inventories increased by $334,000 due to an increase in finished goods inventory and the timing of raw material purchases. The trade receivables increase of $162,000 was related to increased sales volumes. The Company believes that the quality of its receivables is high and that strong internal


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controls are in place to maintain proper collections. Prepaid expenses and other assets increased $59,000, reflecting insurance premiums paid in advance in the first quarter of 2014. Accounts payable increased $346,000 due to the increase in raw material purchases and the timing of vendor payments. Accrued expenses increased $87,000, reflecting the timing of insurance and compensation payments while income taxes receivable decreased $16,000 and income taxes payable increased $86,000 due the timing of estimated tax payments compared to the calculated 2014 tax liability.

During the first three months of 2013, inventories increased by $286,000 due to increased raw material purchases. The higher raw material purchases were due to the Company's efforts to take advantage of volume discounts. The trade receivables increase of $124,000 was related to the increased export sales volumes which tend to have longer collection cycles. The Company believes that the quality of its receivables is high and that strong internal controls are in place to maintain proper collections. Prepaid expenses and other assets increased $28,000, reflecting insurance premiums paid in advance in the first quarter of 2013. Accounts payable increased $149,000 due to of the timing of payments to vendors and the increase in raw material purchases. Accrued expenses increased $60,000, reflecting the timing of compensation payments while income taxes receivable increased $72,000 and income taxes payable decreased $74,000 due the timing of estimated tax payments compared to the calculated 2013 tax liability.

During the first quarter of 2014, cash generated from investing activities was $72,000. Three certificates of deposits totaling $555,000 matured during the first three months of 2014. The Company also invested $350,000 in two fully insured certificate of deposit during the same time period. The Company purchases of property and equipment were $124,000, mainly improvements to Micro-Machining equipment, two forklifts and a vehicle. Also during the first quarter of 2014, the Company incurred $17,000 in patent application costs that the Company records as an asset and amortizes upon successful completion of the application process.

During the first quarter of 2013, cash used in investing activities was $245,000. Purchases of property and equipment were $207,000, mainly upgrades to research and development equipment and facilities. These upgrades include improvements to both DTX equipment and equipment and facilities related to screen printing. Capital expenditures were also made to improve Micro-Machining capabilities. Also during the first quarter of 2013, the Company incurred $36,000 in patent application costs that the Company records as an asset and amortizes upon successful completion of the application process. The Company also invested $205,000 in a fully insured certificate of deposit during the first quarter of 2013. One certificate of deposit totaling $204,000 matured during the first three months of 2013.

During the first three months of 2014, the Company received $13,000 from financing activities from the issuance of 2,083 shares of common stock from the exercise of stock options compared to the $41,000 the Company received from the issuance of 7,110 shares of common stock from the exercise of stock options in the first quarter of 2013.

A bank line of credit exists providing for borrowings of up to $1,250,000 and expires on May 31, 2015 if not renewed. The Company expects to obtain a similar line of credit when the current line of credit expires. The line of credit is collateralized by trade receivables and inventories and bears interest at 2.5 percentage points over the 30-day LIBOR rate. The Company did not utilize this line of credit during the first three months of 2014 or 2013 and there were no borrowings outstanding as of March 31, 2014 and 2013. There are no financial covenants related to the line of credit.

The Company believes that current financial resources, its line of credit, cash generated from operations and the Company's capacity for debt and/or equity financing will be sufficient to fund current and anticipated business operations. The Company also believes that its low debt levels and available line of credit make it unlikely that a decrease in demand for the Company's products would impair the Company's ability to fund operations.

Capital Expenditures

Through the first three months of 2014, the Company spent $124,000 on capital expenditures. Capital expenditures during the first three months were mainly for improvements to Micro-Machining capabilities, two


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forklifts and a vehicle. The Company expects capital expenditures in 2014 of approximately $600,000. Plans for capital expenditures include mandatory elevator upgrades, additional Micro-Machining equipment and a vehicle. These commitments are expected to be funded with cash generated from operating activities.

International Activity

The Company markets its products to numerous countries in North America, Europe, Latin America, Asia and other parts of the world. Foreign sales were approximately 27% of total sales during the first three months of 2014, compared to 36% of sales in the first quarter of 2013. Lower sales volumes in Asia unfavorably impacted 2014 first quarter sales volumes. Fluctuations of certain foreign currencies have not significantly impacted the Company's operations because the Company's foreign sales are not concentrated in any one region of the world. The Company believes its vulnerability to uncertainties due to foreign currency fluctuations and general economic conditions in foreign countries is not significant.

The Company's foreign transactions are primarily negotiated, invoiced and paid in U.S. dollars, while a portion is transacted in Euros. IKONICS has not implemented an economic hedging strategy to reduce the risk of foreign currency translation exposures, which management does not believe to be significant based on the scope and geographic diversity of the Company's foreign operations as of March 31, 2014. Furthermore, the impact of foreign exchange on the Company's balance sheet and operating results was not material in either 2014 or 2013.

Future Outlook

IKONICS has spent on average approximately 3% to 4% of its sales dollars for the past few years in research and development and has made capital expenditures related to its DTX and Micro-Machining programs. The Company plans to maintain its efforts in this area and to expedite internal product development as well as form technological alliances with outside experts to commercialize new product opportunities.

The Company continues to make progress on its new Micro-Machining business initiative. The Company has entered into agreements with several major aerospace companies to determine the feasibility of using its unique technologies in the production of military and commercial aircraft. The Company is currently supplying products to four aerospace companies for use in the construction of new generation commercial aircraft. Although sequestration of the Department of Defense budget and delays in the launching of new commercial aircraft fleets could adversely affect some of these sales, progress is being made on a number of in-house feasibility projects, and the Company believes that several of these could lead to ongoing business. In anticipation of this business, the Company is expanding its Micro-Machining manufacturing capacity.

The Company is also continuing to make progress on its DTX business initiatives. In addition to its growing inkjet technology business, the Company is having a good market reception to its complementary photographic technology film aimed at smaller users and has introduced a fluid for use in prototyping. The Company is currently working with its DTX customers on training, production optimization, and product improvements. The Company has been awarded European and United States patents on its DTX technologies.

Domestically, both the Domestic and its IKONICS Imaging units remain profitable mature markets and require aggressive strategies to grow market share. Although there will be challenges, the Company believes these businesses will continue to grow and prosper. In addition to its traditional emphasis on domestic markets, the Company will continue efforts to grow its business internationally by attempting to develop new markets and expanding market share where it has already established a presence.

Other future activities undertaken to expand the Company's business may include acquisitions, building improvements, equipment additions, new product development and marketing opportunities.


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Recent Accounting Pronouncements

The Company does not expect that the adoption of any recent accounting pronouncements will have a material impact on its financial statements.

Off Balance Sheet Arrangements

The Company has no off-balance sheet arrangements.

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